China

China and Schumpeter's 'Creative Destruction'

It’s a key question raised in a novel way as Xi Jinping and other leaders aim to take economic reform in China to the next level. “If, as Joseph Schumpeter said, creative destruction is the “essential fact about capitalism,” then just how capitalist is China?” asks a report released on Feb. 10th by Beijing-based China economic consultancy GavekalDragonomics.

As the economist Schumpeter saw it, creative destruction is a positive force, driving weaker companies to disappear and be replaced by more innovative ones. Or as the Austrian American economist himself wrote in his 1942 book Capitalism, Socialism and Democracy, it’s a process that “incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.”

The Gavekal report, written by Indiana University political scientist Scott Kennedy, looks at statistics showing annual registration of new enterprises and company closures compiled by China’s State Administration for Industry and Commerce. The conclusion, which may not be so surprising: China is good on creation, not so hot on destruction.

Indeed, the numbers show that last year 11.3 million new companies were registered in China, with 95 percent of them private enterprises or so-called getihu, tiny firms also known as sole proprietorships. “The dismantling of the planned economy over the past two decades has led to a tremendous boom in the creation of new private-sector firms,” writes Kennedy in the report.

Perhaps less encouraging for fans of Schumpeter is China’s record on the exiting side. While in the last few years not more than 8 percent of China’s existing firms have been shuttered annually, the rate in the U.K. has been around 10 percent, and in the U.S. over 13 percent. “Today American and European companies are five times more likely to die in their first year as Chinese companies,” writes Kennedy.

Worrying, too, is the fact that companies shuttered in China usually are private, not the state-owned enterprises (SOEs) that often are the worst performers. For example, more than three-fifths of all Chinese companies that closed from 2008 to 2012 were in sectors of manufacturing dominated largely by private companies: wholesale and retail trade and shipping and storage. “By contrast, the sectors that suffered the fewest deaths during this period had a higher proportion of SOEs: mining, electric power, finance and education,” writes Kennedy.

“Many of China’s distinctive economic policies seem to be devoted to avoiding corporate failures,” he notes, citing easy credit from state-owned banks and the shadow financial sector, as well as a variety of beneficial policies from local governments aimed at supporting companies that are big employers. “Accepting market exit not just as a necessary evil but something to be actively encouraged may not come easy to Chinese policymakers,” the report concludes.